The S&P 500 is three-percent from bear market territory (the NASDAQ is already there), the DOW is accelerating its losses, down 462 points today amid partial government shutdown fears, and down 1400 points from its post-fed statement highs yesterday.

For the year-to-date, this is the worst showing for U.S. equities since 2008 and is the poorest month for blue-chip Dow stocks since August 2015 – keeping in mind that December is almost always a period when the market rallies.

Over the last several weeks we have seen a rise in volatility and what may feel like an unrelenting sell-off across most asset classes. In fact, the S&P 500 has not had a similar 10-day decline since August 2015. While we have now seen a couple of 10% corrections this year, it is important to remember that these episodes have historically occurred on average every two years going back to 1929.

While the one-quarter percentage point increase in the Fed’s key federal-funds target rate, to 2.25%-2.50%, was what most market participants and forecasters had anticipated, the policy-setting Federal Open Market Committee said it still “judges that some further gradual” rate hikes would be consistent with its optimistic economic outlook for 2019.

Market participants had hoped for a “one and done” statement that would indicate the FOMC was putting policy on hold amid the current turbulence in the stock, credit, and commodity markets.

The Fed’s balance sheet has contracted 7.7% from a year-ago levels. This is the first time this has happened since the stock market bottomed nearly a decade ago.

The Federal Reserve seems content to gradually slow the U.S. economy, in order to stamp out inflation, or the potential of inflation. While liquidity has become a critical constraint for the equity markets, there can be no doubt that global investors are repricing for slower economic growth conditions.

That said, we have largely been prepared for the current environment. Earlier this year, we encouraged investors to take preemptive steps to reduce exposure to broad equity markets by raising cash from domestic equities, developed international equities, and emerging markets. Those steps have helped dampen the full impact of the current drawdown and will provide investors with capital to deploy once market conditions improve.

As we continue monitoring market developments, we want to let you know that we are paying close attention to market developments, and are prepared to recommend further de-risking of portfolios to preserve capital should conditions warrant. We are currently watching key longer-term technical signals across broad equity markets and should a sell signal occur, we believe it would make sense further reduce equity exposure.

We appreciate your trust and work hard to help you meet your goals and objectives.

That said, if you have any questions please don’t hesitate to let us know.

Finally, all of us at STA Wealth wish you and your family a Blessed Christmas.

Happy Holidays!

What Investing Lessons Has 2018 Taught Us?

Despite solid global economic fundamentals, 2018 has turned out to be the most challenging year for investors in a decade. The year started with buoyant sentiment: most investors believed that synchronized global growth could continue with the boost from U.S. tax cuts and an expansion of fiscal spending.

As we near the end of the year, however, few major asset classes have outperformed cash. Returns in many bond, equity and credit markets globally are likely to finish the year in negative territory. So what happened and what lessons should we learn from the last 12 months?

Lesson No. 1 – the pace of economic growth can shift quickly.

Global growth made a sharp turn in 2018, going from synchronized acceleration to synchronized deceleration. The PMI (Purchasing Managers Index) is a widely used leading indicator to gauge the economic outlook – either positive or negative. The heat map below shows that the slowdown in growth is mostly noticeable in continental East and Southeast Asia as well as Europe. Entering 2018, most investors focused on the economy overheating and the risk of increased inflation pressures. As time passed, weaker-than-expected economic data sparked growth slowdown fears. To be sure, the global economy is still growing at a decent pace and we don’t foresee a US recession in 2019.

Lesson No. 3 – the Federal Reserve and monetary policy matter.

This year we have witnessed how the 800-pound gorilla of U.S. monetary policy might unleashed itself on capital markets. In 2018, the Fed increased the Fed Funds rate three times, making the short-term yield top inflation for the first time in a decade. As a result, cash became a viable alternative to riskier assets, which caused capital outflows from stocks and high yield bonds to money market and short-duration bonds. The unwinding of a ballooning balance sheet drove up long-term rates, making mortgages less affordable and helped cool the real estate sector. The rising costs of borrowing also leaves companies with weak fundamentals exposed when refinancing becomes an issue and bankruptcy is unavoidable. The rising US yield significantly strengthened the US dollar in 2018 and hit emerging market assets particularly hard. That said, the future tightening path and a possible pause in rate hikes stands to have many implications for the investment landscape in 2019.

Source: Bloomberg

Although 2018 has been a tough year for investors, the outlook for long-term return potential has actually brightened as valuations across major assets have decreased and look particularly attractive in emerging markets. See chart below.

However, given the maturity of the current cycle and heightened near-term risks, we believe that investors will be better rewarded by building resilience into their portfolios via a combination of defensive stocks and high-quality bonds while looking for value opportunities in selective asset classes. It will also be key to have a tactical management strategy in place for when volatility picks up, and may ultimately be the biggest key to investment success in 2019.

Weekly Technical Comment

Indexes Hitting New 52-Week Lows

In last week’s newsletter, we included a piece entitled “S&P 500 May Have More Downside to Come”. The technical pattern over the past two months has not been encouraging and the interpretation increased the odds of recent lows being broken.

As you may know the S&P 500 did have more downside. As of today’s close the market is down just over 7% since those comments. Surely you’re not surprised.

Two of the earliest warning signs since October that the stock market was in trouble was the fact that economically-sensitive stock groups like small caps and transports were leading the market lower. The first chart below shows the Russell 2000 Small Cap Index undercutting its February intra-day low to put it at a new 52-week low. Chart 2 shows the Dow Transports doing the same. Weakness in those two groups is a negative warning sign for the market and the U.S. economy. So is the drop in our last chart. Chart 6 shows the S&P Retail SPDR (XRT) also falling to a new 52-week low. And that’s happening during the Christmas shopping season which is supposed to be the best time of the year for retailers. It seems clear from the heavy selling in those three groups, and the rest of the market, that investors are bracing for bad economic news in the new year. And they’re not waiting around to hear that news. That’s why stocks usually peak before the economy. And why we can’t use old economic data to predict the direction of the economy or the stock market.

The end of the year presents a unique opportunity to look at your overall personal financial planning situation. With factors like the 2018 tax law changes, life changes or just working towards your goals, now is an especially important time to review things. It is always a good time to see if you are on-track at your stage in life. Taking what we now know about the new tax law and weaving together all of the other areas of your personal finances is one of the key ways we provide value to you as your trusted adviser. Below are some things we’d like to help you think through before the year ends.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.

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